How Index Investing Can Save You From Yourself

[DaveR]

Buying High and Still Winning

I own index funds, but as much as I like them, I’ve sometimes been critical of their approach. The biggest target of my ire over the years has been the S&P 500, because on several occasions, the folks who run the index seem to buy shares of popular yet controversial companies only after they’ve seen huge gains.

The first time I got annoyed with S&P 500 index funds was back when Meta Platforms (NASDAQ: FB) went public in 2012. The company then known as Facebook had taken the world by storm, but unlike billions of people around the world, the social media giant never resonated with me. I was happy not to invest in it when it went public, and wasn’t surprised to see it lose value after its IPO.

Yet by December 2013, Facebook had fully recovered and kept rising. Only then did S&P Dow Indices decide to add Facebook’s stock to the S&P 500. Moreover, they gave investors notice, allowing the stock price to get bid up higher so that index fund investors would end up paying a lot more than they would have if they’d bought immediately before the announcement. In the end, Facebook went into index funds at $55.12 per share, or more than $6 per share higher than when the announcement came out just a week and a half earlier.

I was irate, but Facebook was a big contributor to the S&P’s return. The social media stock has risen almost 500% in those eight years, versus about a 200% gain for the index. In other words, if I’d had my way and S&P index funds had never bought Facebook stock, fund shareholders would’ve been worse off.

Doubling Down on a Mistake

Even with that experience, I had the same criticisms about the S&P 500 inviting Tesla (NASDAQ: TSLA) into the fold in December 2020. I felt much more justified in Tesla’s case, because the electric vehicle stock had already soared 388% in 2020 before the mid-November announcement. By the time the stock actually got added the following month, Tesla’s year-to-date gains had soared to 730%. Then, when the deed was done, Tesla shares promptly fell 8% in the subsequent two days.

Yet even with Tesla, index fund owners eventually won out. The stock is up more than 50% since December 2020, versus a 28% gain for the S&P 500. I was wrong again.

Let Index Funds Clamp Down on Your Emotions

I’ll admit it: I let my feelings get in the way of my ability to analyze Facebook and Tesla dispassionately. A lot of it has to do with my negative perception of CEOs Mark Zuckerberg and Elon Musk. Even after their huge successes, I still find myself skeptical of their motivations.

But as an index fund investor, I’ve still benefited from the accomplishments that Musk and Zuckerberg have achieved. That in itself is a testament to the way that index funds can save investors from themselves when they can’t help but be irrational about some part of their investing strategies.

Trying to escape all of your biases and beliefs is a hopeless cause. What’s important is to know that those biases are there. Once you do that, you might find that owning an index fund is the best way to ensure you reap the rewards of investing in a wide swath of great companies.